THETA - The Decay Factor



Theta is one of the most important and widely used options Greeks. It is often called time decay, as it measures the rate at which an option's value decreases as time passes.


Theta measures the change in the value of an option with respect to time. It is the rate of change of an option's value with respect to time, all else being equal. When we say "all else being equal," we mean that the other factors that affect an option's value, such as the underlying price, volatility, and interest rates, are held constant.


Theta is negative for all options, as the value of an option decreases with time. As time passes, there is less time left for the option to move in the money, and so its value decreases. The amount by which an option's value decreases with time is measured by its theta.


For example, let's consider a call option on a stock with a strike price of ₹50 and an expiration date in six months. The option's current price is ₹5, and its theta is -0.02. This means that for each day that passes, the option's value will decrease by ₹0.02, all else being equal.


The effect of theta on an option's value increases as the expiration date approaches. At expiration, an option's theta is zero, as there is no more time left for the option to lose value.


Theta is an important factor to consider when trading options. It means that options buyers need to be aware of the time decay factor and make sure they give themselves enough time for their trades to work out. It also means that options sellers can profit from time decay by selling options with shorter expiration dates.


Theta also has implications for options strategies. Options strategies that involve selling options, such as covered calls and credit spreads, can benefit from the effects of time decay on option prices. On the other hand, strategies that involve buying options, such as long straddles and long strangles, can be negatively impacted by time decay.


Summary

Theta is an important options Greek that measures the rate of change of an option's value with respect to time. It is negative for all options, as the value of an option decreases with time. The effect of theta increases as the expiration date approaches, making it an important factor to consider when trading options.